Sri Lanka considering using RBI swap to buy sovereign bonds: CB Governor

COLOMBO (EconomyNext) – Sri Lanka is considering using a 1.5 billion US dollar Reserve Bank of India swap line to buy into sovereign bonds issued by the government, Central Bank Governor Arjuna Mahendran said.

Sri Lanka is planning to sell a sovereign bond to raise up to 1.5 billion US dollars, there had been some investor meetings.

Sri Lanka sold a 500 million US dollar tranche of sovereign bonds at 5.125 percent in April 2014. But the security with 4-years to expiry is quoted around 5.3/5 percent according to Bloomberg newswires data.

A new 5-year bond may require an additional 20 to 30 basis points to be added, sources familiar with international pricing say. A 10-year Sri Lanka dollar bond issued in 2012 with 7-years to expiry is quoted around 5.9 percent.

Mahendran said using the swap facility to buy in the bond could lower the interest cost and the possibility was being considered.

There was no bar to holding government bonds in the central bank balance sheet, he said.

It would also not be equivalent to printing money since dollar assets would be in foreign reserves even if the dollars were later exchanged for rupees, he said.

While a sale or purchase of central bank reserves in return for an asset such as a government debt is ‘monetary policy neutral’ any transaction that that changes the outstanding value of its currency note will change the domestic money supply.

If dollars are sold to the Central Bank, reserves would rise temporarily while the domestic monetary base (notes in circulation and commercial deposits at the Central Bank) would also expand.

Unless the liquidity is permanently mopped up through domestic operations (sales of rupee securities by the Central Bank into the banking system), the money will eventually hit the forex markets as import demand via bank credit, requiring the exchange rate to be defended with unsterilized dollar sales.

This may leave the Central Bank with a net liability to the Reserve Bank of India. Sri Lanka government dollar denominated bonds, though strictly speaking a domestic asset, can be sold in the secondar market to acquire actual foreign assets.

Sri Lanka has been engaged in (unsterilized) dollars sales over the past several months as temporarily sterilized excess liquidity was ending up in the forex markets as import demand when domestic credit picked up.

However the tightening of monetary policy and rise in gilt yields over the past two weeks can help drive more savings to the government credit markets and reduce private credit.

Update II